The Game with Alex Hormozi - The Pie Equation | Ep 253

Episode Date: November 27, 2020

This is my most used equation in business. Today, Alex (@AlexHormozi) talks about the one equation you must know to fully understand where your business stands, the lifetime value of your customers, and where you'll cap. Welcome to The Game w/Alex Hormozi, hosted by entrepreneur, founder, investor, author, public speaker, and content creator Alex Hormozi. On this podcast you’ll hear how to get more customers, make more profit per customer, how to keep them longer, and the many failures and lessons Alex has learned on his path from $100M to $1B in net worth.Timestamps:(1:27) - The number one equation Alex uses the most in all of business(4:30) - The Pie Equation helps make quick calculations to know where you're at(8:42) - The importance of using all three variations of the equation & The Golden Ratio(12:20) - The quick recap of The Pie Equation and the last way to use itFollow Alex Hormozi’s Socials:LinkedIn | Instagram | Facebook | YouTube | Twitter | Acquisition

It is the sweetest equation ever. I love it. Welcome to the game where we talk about how to get more customers, how to make more per customer, and how to keep them longer, and the many failures and lessons we have learned along the way. I hope you enjoy and subscribe. What's going, everyone? I've got a super special podcast slash video for you today. What I want to talk to you about is how to answer the hardest questions in business

using one math equation that only has three variables. And don't worry, it's like it'll be worth it. This is the number one thing. This is the number one equation that I use in my entire life, all right, for business. It's the one that I use most frequently. And where this all started for me was I remember when I had my gyms, which is a recurring revenue business, obviously, I just, I wanted to know how we were doing. But, you know, my data tracking wasn't great.

And I, you know, it's just like, stuff was all over the place. And I just didn't know how we were doing and what we were on track for. And I just didn't know how it worked. And I was like, man, I wish I could just like see into the business. the future, I wish I knew what this would end up like, right? And so I was playing around with math stuff, and this is actually at a time when I was trying to get better at math, because I'm not, I wasn't naturally good at math. And so I would just like try and like write out what, like how I would try and calculate this and I really struggled with it. And one day I was driving and it actually

just hit me. I was like, what if I just divided it by this? And that would just tell me the number. And it turns out I was right. And so what I want to explain to you is the number one of equation that I use the most in all of business, and I call it the pie equation. All right. Now, it has nothing to do with pie, PI, right? And it has everything to do with any kind of, just, I mean, really just all business. It is the sweetest equation ever. I love it.

I use it all the time. All right. So what is the pie equation? Why is it called pie? I actually think I was dieting at the time. So I called it pie because it looked like a pie when I drew it out. Pie like the pie you eat. No actual real reason.

call it this and for some reason it has stuck all right and so it is a simple equation it is a division equation all right very simple draw a big line here all right and what it essentially is i'll draw a smaller one here just so you can see it is inflow divided by outflow all right so why is this useful so for me i like to have a very good idea of where my business is at where whether growing, whether we're shrinking. What if we just did this for the rest of a year or forever, what we'd end up at? And that is exactly what this question answers. What's important about this is that the inflow is actually a rate thing. So basically you're dividing rates to get an outcome. I'm not going to get super into it because that's not what's important. What's important is understanding

what it will give you, which is your hypothetical max. And it gives you three different hypothetical maxes so you can calculate stuff for your business. So for example, let's say I have an inflow of five new customers per month. I get five new customers a month. And let's say that my churn on my membership, my recurring, my service, whatever, right, is let's say it's 10%. All right. So that's 0.1, 10%. All right. So if I want to know what the max amount of customers I will be able to have given this inflow, I can project that. So right now, if I have, let's say, 30 clients, if I'm doing this and getting five new clients a month and losing 10%, it means that I will be growing, because 10% of 30 would be 3, and I'm getting 5, right? But at some point in the future, right, as I go on,

there will be a point where 10% is equivalent to 5, and at that point, I'd reach equilibrium. And so that is when I would have reached my hypothetical max. And so why this is so important is that when I do this little equation, let's say it's five divided by 0.1, which is 50, right? Which means 50 is going to be my hypothetical max. So I know that if I'm signing up five people every month and I'm losing 10% of my clients every month, that I will reach a business that has 50 clients on average. And I will not be able to increase that number ever unless I'm going to,

I either increase the amount of people I sign up, the rate at which I sign them up, or I decrease the rate at which people leave. And that's it. Pretty cool, right? Like this equation has like changed my life. So what it does is it allows me to make very quick calculations to understand where I'm out, whether we're doing well,

whether we're shrinking, et cetera. So for example, if we had the same equation where I said I had 30 people right now, and I said I'm signing up two people a month, right? And I've got 10% churn, then I'm know that the hypothetical max of that is 20, right, is 20, which means that I'm going to be shrinking from 30 to 20 over the next however many months unless I fix this. And so it gives me a very clear snapshot of what, whatever I'm currently doing extrapolates into the future. Now, you probably

already have some ideas of how you could use this in your business, right? This gives you a hypothetical max it projects out your current rate so you can understand where you're going. That's the point. All right. Now, let me draw a little dotted line here. That is the first use of this equation. The second use is understanding lifetime value. All right. So let's say that we have a client and the average revenue per client that we have per month, let's say is $500. All right. So let's say it's, let's use a different number. I'll say $1,000. All right. That's a little simple. All right. So $1,000 per month is my average revenue per client. Now, let's say that, I can keep a $1,000 per month client for five months. So my churn, right, the percentage that would leave every month would be 20%. All right. So 20%, which would be 0.2, right, is my rate of people leaving. 20% of my customers.

So if I have 10 customers to leave every month, it's 20%. All right, that's churn. Now, when I phrase the equation or whatever, when I frame it this way, I can now extrapolate how much this person is worth to me. So if I know that my average person pays me $1,000 a month, and I know that on average, 20% of my customers leave every month, then I know that my customers aren't average worth $5,000, which is $1,000 divided by .2.

Pretty sweet, right? So now I know that if all customers that come to me, if I change nothing are worth $5,000, then that gives me a number that I can go and market with. I know that I can spend at least $1,000, $2,000, to go acquire this customer, right? I'm using rough math. It would be less than $2,000.

You wouldn't be a 3 to 1. I'm not going to get into that right now. That's the point here is that this would give me rough math to know how much I could spend to a car customer. That's super useful. Now, with these two things together, I can know where my business is going to stall. I can also see how I can manipulate these variables in order to know where my business is going to reach. Now, I can also see if I'm increasing, if I'm growing my business, or if my business is shrinking, simply by knowing what my inflow of customers in versus my outflow.

Now, you can also do this on a bigger scale. I said it's three variations of the same concept. Now, let's say I'm signing up $10,000 a month of new business. So this is the same concept as this, what I was talking about over here, where you know I'm signing up five customers a month, but this is just basically combining the first two things into one overall number.

So I'm signing up $10,000 a month of new business. That's what I'm signing up in new business, per month. Now, if I know that I'm losing, again, 10% of my revenue per month, then I know that's 10%, oops, which is 0.1, right, or 0.1, then I know that this business is going to cap out at $100,000 per month. Hey, guys, real quick, if you're new to the podcast, I have a book on Amazon, it's called $100 million offers that over 8,000 five-star reviews and it has almost a perfect score. You can get it for 99 cents on Kindle. The reason I bring it up is that I put over a thousand hours into writing that book. And it's my biggest gift to our community. So it's my very

shameless way of trying to get you to like me more and ultimately make more dollars so that later on in your business career, I can potentially partner with you. So that's my give. Go check it out, Amazon and back to the show. Now again, the reason that that's important and the reason that I use all three of these variations of this equation is because I can see if I'm shrinking or I'm getting bigger. If I know that we signed up $10,000 in a month and we're doing 10% turn and I know we're going to extrapolate out to $100,000 a month. But if we're currently at 200, I'm like, that's not good. We need to fix something. Or if we're at 50, I'll be like, that's awesome. We're going to double. But the thing is, is that you're going to double and then you're going to cap. And what's more

is that as you do this, unless you have negative churn, which most people do not have in service-based businesses, what's going to happen is that your rate of growth is going to slow. So it looks like this. And so this is going to be your hypothetical max, right, at the top here. And so what happens is you quickly, like when you have zero clients, when you sign up 10 people, right, boom, you have a huge explosion in growth, right? Percentage-wise, it's like a vertical line. But the next month, when you have 10 and you lose two,

now you have eight, but then you gain another 10, but you only gained eight, right? But then now you lose 10% again, right? So you lose, or sorry, 20% again, but now you lose 3 because 10% is bigger of 18, right? So now you drop down to 15, but then you add another 10, right? But now you're at 25, but you notice how the rate goes from 10 to 8 to 7, right?

The growth continues to slow down over time because churn eats out a bigger and bigger percentage, right? And so, with this, you can know that this is going to be your hypothetical max. Realistically, though most businesses have enough volatility, that once you're at about 80, 90% of your max, which would be like right here, right, is realistically where you'll usually end up capping up because your fluctuations in business are such that. That's around where you're going to be. Now, I'm going to add in a bonus thing for you, which is called the golden ratio.

And so the golden ratio is the way to beat this equation so that you actually never end your growth. here's how it works. We're going to have two rates. So you have the rate of people leaving, right? Leaving percentage. You can put that as whatever you want. The fancy word is turn.

Leaving percentage, excess percentage, cancel percentage, whatever. And then here, you have your referral percentage. This is where things get magical. So, if 10% of your customers were to refer a new customer every month and 5% of your customers leave every month, then, you have 10% over 5%,

and it means that your business will double every growth period. It basically just, it will continue to unendingly grow because the more people who come in from referrals, a smaller percentage leave every month. And this is called net negative turn. This is where you have a business that grows faster than it turns on its own without paid advertising because your product is so good.

That is where we all want to go, This is the promised land. This is the golden ratio, which is what I call it. And when you can achieve this, you can grow forever. Now realistically, you don't grow forever, because you'll get big enough and you'll mess something up. And then all of a sudden, your referral percentage will go down or your turn percentage will go up.

One of those things happen. But when you can achieve this for a period of time, that is when you have crazy growth. Because not only are you getting customers from your normal acquisition channels, but you're actually the percentage of customers who refer, which is why it's important, it stays fixed and it's greater than your percentage turn. And so it just continues to grow and grow and grow, which is awesome.

So as a quick recap for you, the pie equation is the most used equation that I use in all of business, especially if you have a recurring revenue-based business. But even if you do not, it's still an awesome equation. And I use it in three specific ways. One is so that I can know whether I'm growing or shrinking, number one. Number two, I used to extrapolate out what my current acquisition versus my outflow rate, how much I'm going to level out at, this equation gives me that answer. To the same degree, it also gives me my hypothetical lifetime value per client.

So I can know that how much I can spend to acquire a customer because I can know exactly what they're going to be worth to me, give them their return and what they pay me on average per month. And again, I can put all those things together into one number where I say I'm starting up this much new business per month and this much business is leaving and this is going to be my overall number, this top number, is going to be the overall number that I'm going to be able to generate per month in my business. And so putting all these things together is I use this equation, I mean, five times a day. I use it all the time.

I use it when I'm coaching people. I use it when I'm thinking about how we're doing. And this is the type of back and nap and math that I feel like every entrepreneur needs to have in order to be able to understand where their business is and how it's doing. And let me show you one more way to use this because like I said,

I use this equation literally every day all the time. And it's by combining two of those pieces. So if I had, like I said earlier, let's say I had $5,000 was the lifetime value that I calculated, right, which was based off of $1,000 per month divided by 20% churn, right? That gives me my $5,000.

Now, let's say that I know that I'm signing up 20 clients a month, I can know that simply by these two numbers, if I know what my inflow is, 20 clients a month, and I know that they're going to be worth $5,000 total, then I know that my business is going to level out at $100,000 per month. All right? This is like the biggest thing ever. This is how this, like, the whole game works. Like, this is the equation.

This is how everything that I do extrapolates. off of this thing. All right? And so 20, right, per month. Now here's where it gets tricky because you're like, well, that makes sense. It's math. Yeah, but it doesn't look like that when you're in it. Because when you're in it, you signed up 20 customers and you're at $1,000 a month per

customer. You're doing $20,000 a month. And you don't know if you're doing well or not because you don't can't see into the future to see that if you just keep doing what you're doing and you don't break it and you don't get entrepreneurial ADD and you don't get shiny objects to do it. If you just keep doing what you're doing and every month you drop another 20 in, right? You drop another 20 in, you drop another 20 in, then you're going to get to $100,000 a month. Right?

It takes time for recurring revenue businesses to gain traction. And so if you understand this, it can give you kind of this peace of mind and understanding where you're going, where you're at, whether you're growing, whether you're shrinking, and what you need to do to fix it. Because with these equations, you can say, either I have to increase the lifetime value, I have to buy either increasing the price or decreasing the turn, which is one of those two things, or I have to increase my inflow. And simply by understanding those three pieces, piece number one, which is your price, piece number two, which is your turn, piece number three, which is your inflow. If you understand those three pieces, then you can understand exactly how to make your business however big you want. So that is the pie equation. This is the most used equation that I use. I wish I could have a sexier title for this because everyone needs to watch it and understand it in absolute depth because this is everything.

When I talk to a business owner, when they're struggling, when they don't know what to do, this is what I use. this is it. This is what I use. When I'm trying to figure out with their business, I'm like, what's your inflow? What's your turn? What's your average price per user? It's the first thing I'm asking.

Literally, it's the first two questions I'll ask. And then I'm like, what's your revenue right now? And just by knowing that, I can know whether they're growing, whether they're shrinking, how fast they're growing. I can know where they're going to level out. I can know how many customers they're going to level out at. I can know all of these things simply by asking those four pieces of data and having this equation in my back pocket.

And so I use this every day. It's like I breathe this equation. And the more you play with it, the more you understand it, the more powerful you'll be as an entrepreneur. And I promise you it will be worth mastering. So anyways, hope you enjoy this. Hopefully you like this. Leave a review for, you know, the podcast.

Or if you're watching this on YouTube, leave a nice review, subscribe, all that kind of stuff. Otherwise, keeping amazing. I'm rooting for you. And talk to you soon. Bye.